Interpreting Changes in SPX–VIX Correlation

# When the Inverse Correlation between the SPX and VIX breaks down


# When the Inverse Correlation between the SPX and VIX breaks down












As we all know the S&P and its implied vol, the VIX, generally move in opposite direction. To a large extent, the correlations makes sense. IV is one of the main drivers of the price of options, going long options is also going long IV. When the market drops, option prices, adjusted for the drop in the the S&P price, experience a further appreciation, the extra appreciation o the options above and beyond the the price movement can be attributed to an increase in IV. My question is when IV(the VIX) and SPX correlation breakdown from its usual inverse relationship( corr=-.95), what do you think this implies about future returns? Why does these instances occur? There are many times when the correlations drops to 0 and becomes positive!

Below is a picture with the 20 day correlation between the two indices.

## Answer by Andrew (score 7, accepted)

https://quant.stackexchange.com/a/8022

If you look at tick data, you will probably get an even better analysis. However, vix correlation tends to be negative with spx but remember that this is generally more true for when spx tanks. When spx goes up, the correlation isn't as strong. Why? People panic after a drop, therefore leading to people buying options. They don't care about black scholes delta hedging etc. They only want to hedge their position. However, when spot is going up, vix doesn't necessarily have to go down because if it does go down quite a bit, you buy the option, and just delta hedge and collect the difference between realized and implied volatility.

Another thing that you can also look at is the skew in the options market. When correlation between spot and vol is very high, you tend find a much steeper skew and vice versa.

spx is cash settled so there is no physical to deliver. and spx is so liquid that it is nearly impossible for any individual to move the market. we know that market impact is proportional to sigma * sqrt( (order size) / (average volume) ). on any given day, spx and spy trades at least 2 million contracts. for a big player to move the market, you will literally need to trade at least half a billion which I've personally never seen.

You should do an analysis of realized volatility during the previous 20 days as well. If the realized volatility during the previous 20 days was .16, and the implied volatility was .12, you will still buy the option even if markets were going up no? since you can make a profit from delta hedging.